"You all are the house, you're the bookie. [Your clients] are booking their bets with you. I don't know why we need to dress it up. It's a bet." - Sen. Claire McCaskill, Senate Subcommittee investigating Goldman Sachs (Washington Post, April 27, 2010)

Ever since December 2008, the Federal Reserve has held short-term interest rates near zero. This was not only to try to stimulate the housing and credit markets, but also to allow the federal government to increase its debt levels without increasing the interest tab picked up by the taxpayers. The total public US debt increased by nearly 50 percent from 2006 to the end of 2009 (from about $8.5 trillion to $12.3 trillion), but the interest bill on the debt actually dropped (from $406 billion to $383 billion), because of this reduction in interest rates.

One of the dire unintended consequences of that maneuver, however, was that municipal governments across the country have been saddled with very costly bad derivatives bets. They were persuaded by their Wall Street advisers to buy credit default swaps to protect their loans against interest rates shooting up. Instead, rates proceeded to drop through the floor, a wholly unforeseeable and unnatural market condition caused by rate manipulations by the Fed. Instead of the banks bearing the losses in return for premiums paid by municipal governments, the governments have had to pay massive sums to the banks - to the point of pushing at least one county to the brink of bankruptcy (Jefferson County, Alabama).

Another unintended consequence of the plunge in interest rates has been that "savers" have been forced to become "speculators" or gamblers. When interest rates on safe corporate bonds were around 8 percent, a couple could aim for saving half a million dollars in their working careers and count on reaping $40,000 yearly in investment income, a sum that, along with Social Security, could make for a comfortable retirement. But very low interest rates on bonds have forced these once-prudent savers into the riskier and less predictable stock market, and the collapse of the stock market has forced them into even more speculative ventures in the form of derivatives, a glorified form of gambling. Pension funds, which have binding pension contracts entered into when interest was at much higher levels, need an 8 percent investment return to meet their commitments. In today's market, they cannot make that sort of return without taking on higher risk, which means taking major losses when the risks materialize.

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Derivatives are basically just bets. Like at a racetrack, you don't need to own the thing you're betting on in order to play. Derivative casinos have opened up on virtually anything that can go up or down or have a variable future outcome. You can bet on the price of tea in China, the success or failure of a movie, whether a country will default on its debt, or whether a particular piece of legislation will pass. The global market in derivative trades is now well over a quadrillion dollars - that's a thousand trillion - and it is eating up resources that were at one time invested in productive enterprises. Why risk lending money to a corporation or buying its stock, when you can reap a better return betting on whether the stock will rise or fall?

The shift from investing to gambling means that not only are investors making very little of their money available to companies to produce goods and services, but the parties on one side of every speculative trade now have an interest in seeing the object of the bet fail, whether a company, a movie, a politician or a country. Worse, high-speed program traders can actually manipulate the market so that the thing bet on is more likely to fail. Not only has the market become a casino, but the casino is rigged.

High frequency traders - a field led by Goldman Sachs - use computer algorithms to automatically bet huge sums of money on minor shifts in price. These bets send signals to the market that can themselves cause the price of assets to shoot up or tumble down. By placing high-volume trades, the largest speculative traders can, thus, intentionally "fix" prices in any direction they want.

"Prediction" Markets

Casinos for betting on what something will do in the future have been elevated to the status of "prediction" markets, and they can cover a broad range of issues. MIT's Technology Review launched a futures market for technological innovations, in order to bet on upcoming developments. The NewsFutures and TradeSports Exchanges enable people to wager on matters such as whether Tiger Woods will take another lover, or whether bin Laden will be found in Afghanistan.

A 2008 conference of sports leaders in Auckland, New Zealand, featured Mark Davies, head of a sport betting exchange called Betfair. Davies observed that these betting exchanges, while clearly gambling forums, are little different from the trading done by financial firms such as JPMorgan. He said:

"I used to trade bonds at JPMorgan, and I can tell you that what our customers do is exactly the same as what I used to do in my previous life, with the single exception that where I had to pour over balance sheets and income statements, they pour over form and team-sheets."

The online news outlet Slate monitors various prediction markets to provide readers with up-to-date information on the potential outcomes of political races. Two of the markets covered are the Iowa Electronic Markets and Intrade. Slate claims that these political casinos are consistently better at forecasting winners than pre-election polls. Participants bet real money 24 hours a day on the outcomes of a range of issues, including political races. Newsfutures and Casualobserver are similar, smaller exchanges.

Besides shifting the emphasis to gambling ("Why Vote When You Can Bet?" says Slate's "Guide to All Political Markets"), prediction markets, like the stock market, can be rigged so that they actually affect outcomes. This became evident, for example, in 2008, when the John McCain campaign used the Intrade market to shift perception of his chances of winning. A supporter was able to single-handedly manipulate the price of McCain's contract, causing it to move up in the market and prompting some mainstream media to report it as evidence that McCain was gaining in popularity.

Betting on Terrorism

The destructive potential of prediction markets became particularly apparent in one sponsored by the Pentagon, called the "policy analysis market" (PAM) or "terror futures market." PAM was an attempt to use the predictive power of markets to forecast political events tied to the Middle East, including terrorist attacks. According to The New York Times, the PAM would have allowed trading of futures on political developments including terrorist attacks, coups d'état and assassinations. The exchange was shut down a day after it launched, after commentators pointed out that the system made it far too easy to make money with terror attacks.

At a July 28, 2003, press conference, Sens. Byron L. Dorgan (D-North Dakota) and Ron Wyden (D-Oregon) spoke out against the exchange. Wyden stated, "The idea of a federal betting parlor on atrocities and terrorism is ridiculous and it's grotesque," while Dorgan called it "useless, offensive and unbelievably stupid."

"This appears to encourage terrorists to participate, either to profit from their terrorist activities or to bet against them in order to mislead US intelligence authorities," they said in a letter to Adm. John Poindexter, the director of the Terrorism Information Awareness Office, which developed the idea. A week after the exchange closed, Poindexter offered his resignation.

Carbon Credit Trading

A massive new derivatives market that could be highly destructive economically is the trading platform called Carbon Credit Trading, which is on its way to dwarfing world oil trade. The program would allow trading in "carbon allowances" (permitting companies to emit greenhouse gases) and in "carbon offsets" (allowing companies to emit beyond their allowance if they invest in emission-reducing projects elsewhere). It would also allow trading in carbon derivatives, for example, futures contracts to deliver a certain number of allowances at an agreed price and time.

Robert Shapiro, former undersecretary of commerce in the Clinton administration and a co-founder of the US Climate Task Force, has warned, "We are on the verge of creating a new trillion-dollar market in financial assets that will be securitized, derivatized, and speculated by Wall Street like the mortgage-backed securities market."

Eoin O'Carroll cautioned in The Christian Science Monitor:

"Many critics are pointing out that this new market for carbon derivatives could, without effective oversight, usher in another Wall Street free-for-all just like the one that precipitated the implosion of the global economy.... Just as the inability of homeowners to make good on their subprime mortgages ended up pulling the rug out from under the credit market, carbon offsets that are based on shaky greenhouse-gas mitigation projects could cause the carbon market to tank, with implications for the broader economy."

The proposed form of cap and trade has not yet been passed in the US, but a new market in which traders can speculate on the future of allowances and offsets has already been launched. The largest players in the carbon credit trading market include firms such as Morgan Stanley, Barclays Capital, Fortis, Deutsche Bank, Rabobank, BNP Paribas, Sumitomo, Kommunalkredit, Credit Suisse, Merrill Lynch and Cantor Fitzgerald. Last year, the financial services industry had 130 lobbyists working on climate issues, compared to almost none in 2003. The lobbyists represented companies such as Goldman Sachs and JPMorgan Chase.

Billionaire financier George Soros says cap and trade will be easy for speculators to rig. "The system can be gamed," he said last July at a London School of Economics seminar. "That's why financial types like me like it - because there are financial opportunities."

Time to Board Up the Casinos and Rethink Our Social Safety Net?

Our forebears considered gambling to be immoral and made it a crime. As the Industrial Revolution and the ascendance of capital changed religious mores, gambling gradually gained acceptance, but even within that permissive paradigm, derivative trading was originally considered an illegal form of gambling. Perhaps, it is time to reinstate the gambling laws, board up the derivatives casinos and return the stock market to what it was designed to be: a means of funneling the capital of investors into productive businesses.

Short of banning derivatives altogether, the derivatives business could be slowed up considerably by imposing a Tobin tax, a small tax on every financial trade. "Financial products" are virtually the only products left on the planet that are not currently subject to a sales tax; and at over a quadrillion dollars in trades annually, the market is huge.

A larger issue is how to ensure adequate retirement income for the population without forcing people into gambling with their life savings to supplement their meager Social Security checks. It may be time to rethink not only our banking and financial structure, but the entire social umbrella that our founding fathers called the Common Wealth. The genius of Social Security was its recognition of the basic economic truth that real "security" rests on the ability of a society to provide for and take care of those who, because of age, health or economic conditions, cannot take care of themselves.

Deficit hawks cry that we cannot afford more spending; but according to Richard Cook, a former US Treasury Department official, the government could print and spend several trillion new dollars into the money supply without causing price inflation. Writing in Global Research in April 2007, he noted that the US gross domestic product in 2006 came to $12.98 trillion, while the total national income came to only $10.23 trillion; and at least 10 percent of that income was reinvested rather than spent on goods and services. Total available purchasing power was, thus, only about $9.21 trillion, or $3.77 trillion less than the collective price of goods and services sold. Where did consumers get the extra $3.77 trillion? They had to borrow it, and they borrowed it from banks that created it with accounting entries on their books. If the government had replaced this bank-created money with debt-free government-created money, the total money supply would have remained unchanged. That means a whopping $3.77 trillion in new government-issued money could have been fed into the economy in 2006 without inflating prices. Different proposals have been made concerning how this money should be distributed, but at least some of it could be used to provide adequate Social Security checks, relieving the pressure to gamble with our savings.

The Federal Reserve has funneled $4.6 trillion to Wall Street in bailout money, most of it generated via "quantitative easing" (in effect, printing money); yet, hyperinflation has not resulted. To the contrary, what we have today is Depression-style deflation. The M3 money supply shrank in the last year by 5.5 percent, and the rate at which it is shrinking is accelerating. The explanation for this anomaly is that the Fed's $4.6 trillion added by quantitative easing fell far short of the estimated $10 trillion needed to "reflate" the money supply after the "shadow lenders" disappeared. When these investors discovered that the "triple-A" mortgage-backed securities they had been purchasing from Wall Street were actually very risky investments, they exited the market, credit dried up and the money supply (which today consists almost entirely of credit or debt) collapsed.

The only viable way to reflate a collapsed money supply is to put more money into it; and creating the national money supply is the sovereign right of governments, not of banks. If the government wants to remain sovereign, it needs to reassert that right.

{conment - PdBD}
My friends, I listened to an interview with the author of this July 2010 article in Harpers. IF you have a Harpers subscription, you can log on to read the whole article (I do not). If you have wondered why grain prices soared in 2008? Hey, guess who was primarily responsible? Try Goldman Sachs and you've got it!
{end comment}

The food bubble:

How Wall Street starved millions and got away with it

By Frederick Kaufman

The history of food took an ominous turn in 1991, at a time when no one was paying much attention. That was the year Goldman Sachs decided our daily bread might make an excellent investment.

Agriculture, rooted as it is in the rhythms of reaping and sowing, had not traditionally engaged the attention of Wall Street bankers, whose riches did not come from the sale of real things like wheat or bread but from the manipulation of ethereal concepts like risk and collateralized debt. But in 1991 nearly everything else that could be recast as a financial abstraction had already been considered. Food was pretty much all that was left. And so with accustomed care and precision, Goldmans analysts went about transforming food into a concept. They selected eighteen commodifiable ingredients and contrived a financial elixir that included cattle, coffee, cocoa, corn, hogs, and a variety or two of wheat. They weighted the investment value of each element, blended and commingled the parts into sums, then reduced what had been a complicated collection of real things into a mathematical formula that could be expressed as a single manifestation, to be known thenceforward as the Goldman Sachs Commodity Index. Then they began to offer shares.

As was usually the case, Goldmans product flourished. The prices of cattle, coffee, cocoa, corn, and wheat began to rise, slowly at first, and then rapidly. And as more people sank money into Goldmans food index, other bankers took note and created their own food indexes for their own clients.

Investors were delighted to see the value of their venture increase, but the rising price of breakfast, lunch, and dinner did not align with the interests of those of us who eat. And so the commodity index funds began to cause problems.

Wheat was a case in point. North America, the Saudi Arabia of cereal, sends nearly half its wheat production overseas, and an obscure syndicate known as the Minneapolis Grain Exchange remains the supreme price-setter for the continents most widely exported wheat, a high-protein variety called hard red spring. Other varieties of wheat make cake and cookies, but only hard red spring makes bread. Its price informs the cost of virtually every loaf on earth.

As far as most people who eat bread were concerned, the Minneapolis Grain Exchange had done a pretty good job: for more than a century the real price of wheat had steadily declined. Then, in 2005, that price began to rise, along with the prices of rice and corn and soy and oats and cooking oil. Hard red spring had long traded between $3 and $6 per sixty-pound bushel, but for three years Minneapolis wheat broke record after record as its price doubled and then doubled again. No one was surprised when in the first quarter of 2008 transnational wheat giant Cargill attributed its 86 percent jump in annual profits to commodity trading. And no one was surprised when packaged-food maker ConAgra sold its trading arm to a hedge fund for $2.8 billion. Nor when The Economist announced that the real price of food had reached its highest level since 1845, the year the magazine first calculated the number.

Nothing had changed about the wheat, but something had changed about the wheat market. Since Goldmans innovation, hundreds of billions of new dollars had overwhelmed the actual supply of and actual demand for wheat, and rumors began to emerge that someone, somewhere, had cornered the market. Robber barons, gold bugs, and financiers of every stripe had long dreamed of controlling all of something everybody needed or desired, then holding back the supply as demand drove up prices. But there was plenty of real wheat, and American farmers were delivering it as fast as they always had, if not even a bit faster. It was as if the price itself had begun to generate its own demandthe more hard red spring cost, the more investors wanted to pay for it.

We have never seen anything like this before, Jeff Voge, chairman of the Kansas City Board of Trade, told the Washington Post. This isnt just any commodity, continued Voge. It is food, and people need to eat.

The global speculative frenzy sparked riots in more than thirty countries and drove the number of the worlds food insecure to more than a billion. In 2008, for the first time since such statistics have been kept, the proportion of the worlds population without enough to eat ratcheted upward. The ranks of the hungry had increased by 250 million in a single year, the most abysmal increase in all of human history.

Then, like all speculative bubbles, the food bubble popped. By late 2008, the price of Minneapolis hard red spring had toppled back to normal levels, and trading volume quickly followed. Of course, the prices world consumers pay for food have not come down so fast, as manufacturers and retailers continue to make up for their own heavy losses.

The gratuitous damage of the food bubble struck me as not merely a disgrace but a disgrace that might easily be repeated. And so I traveled to Minneapoliswhere the reality of hard red spring and the price of hard red spring first went their separate waysto discover how such a thing could have happened, and if and when it would happen again. __

The name of the Minneapolis Grain Exchange may conjure images of an immense concrete silo towering over the prairie, but the exchange is in fact a rather severe neoclassical steel-frame building that shares the downtown corner of Fourth Street and Fourth Avenue with City Hall, the courthouse, and the jail.

I walked through its vestibule of granite and Italian marble, past renderings of wheat molded into the terra-cotta cartouches, and as I waited for the wheat-embossed elevator I tried not to gawk at the gold-plated mail chute. For more than a century, the trading floor of the Minneapolis Grain Exchange had been the place where wheat acquired a price, but as I stepped out of the elevator the opening bell tolled and echoed across a vast, silent, and chilly chamber. The place was abandoned, the phones ripped out of the walls, the octagonal grain pits littered with snakes of tangled wire.

I wandered across the wooden planks of the old pits, scarred by the boots of countless grain traders, and I peered into the dark and narrow recesses of the phone booths where those traders had scribbled down their orders. Beyond the booths loomed the massive cash-grain tables, starkly illuminated by rays of sunlight. In the old days, when brokers and traders looked into one anothers faces, not computer screens, they liked to examine the grain before they bought it.

Now an electronic board began to populate with green, red, and yellow numbers that told the price of barley, canola, cattle, coffee, copper, cotton, gold, hogs, lumber, milk, oats, oil, platinum, rice, and silver. Beneath them shimmered the indices: the Dow, the S&P 500, and, at the very bottom, the Goldman Sachs Commodity Index. Even the video technology was quaint, a relic from the Carter years, when trade with the Soviet Union was the final frontier, long before that moment in 2008 when the chief executive officer of the Minneapolis Grain Exchange, Mark Bagan, decided that the future of wheat was not on a table in Minneapolis but within the digital infinitude of the Internet.

As a courtesy to the speculators who for decades had spent their workdays executing trades in the grain pits, the exchange had set up a new space a few stories above the old trading floor, a gray-carpeted room in which a few dozen beige cubicles were available to rent, some featuring a view of a parking lot.

I had expected shouting, panic, confusion, and chaos, but no more than half the cubicles were occupied, and the room was silent. One of the grain traders was reading his email, another checking ESPN for the weekend scores, another playing solitaire, another shopping on eBay for antique Japanese vases.

Were trading wheat, but its wheat were never going to see, Austin Damiani, a twenty-eight-year-old wheat broker, would tell me later that afternoon. Its a cerebral experience.

Todays action consisted of a gray-haired man padding from cubicle to cubicle, greeting colleagues, sucking hard candy. The veteran eventually ambled off to a corner, to a battered cash-grain table that had been moved up from the old trading floor. A dozen aluminum pans sat on the table, each holding a different sample of grain. The old man brought a pan to his face and took a deep breath. Then he held a single grain in his palm, turned it over, and found the crease.

The crease will tell you the variety, he told me. Thats a lost art.

His name was Mike Mullin, he had been trading wheat for fifty years, and he was the first Minneapolis wheat trader I had seen touch a grain of the stuff.

Back in the day, buyers and sellers might have spent hours insulting, cajoling, bullying, and pleading with one another across this tableanything to get the right price for hard red springbut Mullin was not buying real wheat today, nor was anybody here selling it.

Above us, three monitors flickered prices from Americas primary grain exchanges: Chicago, Kansas City, and Minneapolis. Such geographic specificities struck me as archaic, but there remain essential differences among these wheat markets, vestiges of old-fashioned concerns such as latitude and proximity to the Erie Canal.

Mullin stared at the screens and asked me what I knew about wheat futures, and I told him that whereas Minneapolis traded the contract in hard red spring, Kansas City traded in hard red winter and Chicago in soft red winter, both of which have a lower protein content than Minneapolis wheat, are less expensive, and are more likely to be incorporated into a brownie mix than into a baguette. High protein content makes Minneapolis wheat elite, I told Mullin.

He nodded his head, and we stood in silence and watched the desultory movement of corn and soy, soft red winter and hard red spring. It was a slow trading day even if commodities, as Mullin told me, were overpriced 10 percent across the board. Mullin figured he knew the real worth of a bushel and had bet the price would soon head south. Am I short? he asked. Yes I am.

I asked him what he knew about the commodity indexes, like the one Goldman Sachs created in 1991.

Its a brainless entity, Mullin said. His eyes did not move from the screen.

You look at a chart. You hit a number. You buy. __

Grain trading was not always brainless. Joseph parsed Pharaohs dream of cattle and crops, discerned that drought loomed, and diligently went about storing immense amounts of grain. By the time famine descended, Joseph had cornered the marketan accomplishment that brought nations to their knees and made Joseph an extremely rich man.

In 1730, enlightened bureaucrats of Japans Edo shogunate perceived that a stable rice price would protect those who produced their countrys sacred grain. Up to that time, all the farmers in Japan would bring their rice to market after the September harvest, at which point warehouses would overflow, prices would plummet, and, for all their hard work, Japans rice farmers would remain impoverished. Instead of suffering through the Osaka markets perennial volatility, the bureaucrats preferred to set a price that would ensure a living for farmers, grain warehousemen, the samurai (who were paid in rice), and the general population a price not at the mercy of the annual cycle of scarcity and plenty but a smooth line, gently fluctuating within a reasonable range.

While Japan had relied on the authority of the government to avoid deadly volatility, the United States trusted in free enterprise. After the combined credit crunch, real estate wreck, and stock-market meltdown now known as the Panic of 1857, U.S. grain merchants conceived a new stabilizing force: In return for a cash commitment today, farmers would sign a forward contract to deliver grain a few months down the line, on the expiration date of the contract. Since buyers could never be certain what the price of wheat would be on the date of delivery, the price of a future bushel of wheat was usually a few cents less than that of a present bushel of wheat. And while farmers had to accept less for future wheat than for real and present wheat, the guaranteed future sale protected them from plummeting prices and enabled them to use the promised payment as, say, collateral for a bank loan. These contracts let both producers and consumers hedge their risks, and in so doing reduced volatility.

But the forward contract was a primitive financial tool, and when demand for wheat exploded after the Civil War, and ever more grain merchants took to reselling and trading these agreements on a fast-growing secondary market, it became impossible to figure out who owed whom what and when. At which point the great grain merchants of Chicago, Kansas City, and Minneapolis set about creating a new kind of institution less like a medieval county fair and more like a modern clearinghouse. In place of myriad individually negotiated and fulfilled forward contracts, the merchants established exchanges that would regulate both the quality of grain and the expiration dates of all forward contractseventually limiting those dates to five each year, in March, May, July, September, and December. Whereas under the old system each buyer and each seller vetted whoever might stand at the opposite end of each deal, the grain exchange now served as the counterparty for everyone.

The exchanges soon attracted a new species of merchant interested in numbers, not grain. This was the speculator. As the price of futures contracts fluctuated in daily trading, the speculator sought to cash in through strategic buying and selling. And since the speculator had neither real wheat to sell nor a place to store any he might purchase, for every long position he took (a promise to buy future wheat), he would eventually need to place an equal and opposite short position (a promise to sell). Farmers and millers welcomed the speculator to their market, for his perpetual stream of buy and sell orders gave them the freedom to sell and buy their actual wheat just as they pleased.

Under the new system, farmers and millers could hedge, speculators could speculate, the market remained liquid, and yet the speculative futures price could never move too far from the spot (or actual) price: every ten weeks or so, when the delivery date of the contract approached, the two prices would converge, as everyone who had not cleared his position with an equal and opposite position would be obligated to do just that. The virtuality of wheat futures would settle up with the reality of cash wheat, and then, as the contract expired, the price of an ideal bushel would be discovered by hedger and speculator alike.

No less an economist than John Maynard Keynes applied himself to studying this miraculous interplay of supply and demand, buyers and sellers, real wheat and virtual wheat, and he gave the standard futures-pricing model its own special name. He called it normal backwardation, because in a normal market for real goods, he found, futures prices (for things that did not yet exist) generally stayed in back of spot prices (for things that actually existed).

Normal backwardation created the occasion for so many people to make so much money in so many ways that numerous other futures exchanges soon emerged, featuring contracts for everything from butter, cottonseed oil, and hay to plywood, poultry, and cat pelts. Speculators traded molasses futures on the New York Coffee and Sugar Exchange, and if they lost their shirts they could head over to the New York Burlap and Jute Exchange or the New York Hide Exchange. And despite the occasional market collapse (onions in 1957, Maine potatoes in 1976), for more than a century the basic strategy and tactics of futures trading remained the same, the price of wheat remained stable, and increasing numbers of people had plenty to eat. __

The decline of volatility, good news for the rest of us, drove bankers up the wall. I put in a call to Steven Rothbart, who traded commodities for Cargill way back in the 1980s. I asked him what he knew about the birth of commodity index funds, and he began to laugh. Commodities had died, he told me. We sat there every day and the market wouldnt move. People left. They couldnt make a living anymore.

Clearly, some innovation was in order. In the midst of this dead market, Goldman Sachs envisioned a new form of commodities investment, a product for investors who had no taste for the complexities of corn or soy or wheat, no interest in weather and weevils, and no desire for getting into and out of shorts and longsinvestors who wanted nothing more than to park a great deal of money somewhere, then sit back and watch that pile grow. The managers of this new product would acquire and hold long positions, and nothing but long positions, on a range of commodities futures. They would not hedge their futures with the actual sale or purchase of real wheat (like a bona-fide hedger), nor would they cover their positions by buying low and selling high (in the grand old fashion of commodities speculators). In fact, the structure of commodity index funds ran counter to our normal understanding of economic theory, requiring that index-fund managers not buy low and sell high but buy at any price and keep buying at any price. No matter what lofty highs long wheat futures might attain, the managers would transfer their long positions into the next long futures contract, due to expire a few months later, and repeat the roll when that contract, in turn, was about to expirethus accumulating an everlasting, ever-growing long position, unremittingly regenerated.

Youve got to be out of your freaking mind to be long only, Rothbart said.

Commodities are the riskiest things in the world.

But Goldman had its own way to offset the risks of commodities trading if not for their clients, then at least for themselves. The strategy, standard practice for most index funds, relied on replication, which meant that for every dollar a client invested in the index fund, Goldman would buy a dollars worth of the underlying commodities futures (minus management fees). Of course, in order to purchase commodities futures, the bankers had only to make a good-faith deposit of something like 5 percent. Which meant that they could stash the other 95 percent of their investors money in a pool of Treasury bills, or some other equally innocuous financial cranny, which they could subsequently leverage into ever greater amounts of capital to utilize to their own ends, whatever they might be. If the price of wheat went up, Goldman made money. And if the price of wheat fell, Goldman still made money not only from management fees, but from the profits the bank pulled down by investing 95 percent of its clients money in less risky ventures. Goldman even made money from the roll into each new long contract, every instance of which required clients to pay a new set of transaction costs.

The bankers had figured out how to extract profit from the commodities market without taking on any of the risks they themselves had introduced by flooding that same market with long orders. Unlike the wheat producers and the wheat speculators, or even Goldmans own customers, Goldman had no vested interest in a stable commodities market. As one index trader told me, Commodity funds have historically made moneyand kept most of it for themselves.

No surprise, then, that other banks soon recognized the rightness of this approach. In 1994, J.P. Morgan established its own commodity index fund, and soon thereafter other players entered the scene, including the AIG Commodity Index and the Chase Physical Commodity Index, along with initial offerings from Bear Stearns, Oppenheimer, and Pimco. Barclays joined the group with eight index funds and, in just over a year, raised close to $3 billion.

Government regulators, far from preventing this strange new way of accumulating futures, actively encouraged it. Congress had in 1936 created a commission that curbed excessive speculation by limiting large holdings of futures contracts to bona-fide hedgers. Years later, the modern-day Commodity Futures Trading Commission continued to set absolute limits on the amount of wheat-futures contracts that could be held by speculators. In 1991, that limit was 5,000 contracts. But after the invention of the commodity index fund, bankers convinced the commission that they, too, were bona-fide hedgers. As a result, the commission issued a position-limit exemption to six commodity index traders, and within a decade those funds would be permitted to hold as many as 130,000 wheat-futures contracts at any one time.

We have not seen U.S. agriculture rely this much on the market for almost seventy years, was how Joseph Dial, the head of the commission, assessed his agencys regulatory handiwork in 1997. This paradigm shift in the governments farm policy has created a new era for agriculture. ___

Goldman and all the other banks that followed them into commodity index funds had figured out how to safeguard themselves, but there was a lot more money to be made if the banks could somehow convince everyone else that an inherently risky product designed to protect the banksand only the bankswas in fact also safe for investors.

Good news came on February 28, 2005, when Gary Gorton, of the University of Pennsylvania, and K. Geert Rouwenhorst, of the Yale School of Management, published a working paper called Facts and Fantasies About Commodities Futures. In forty graph-and-equation-filled pages, the authors demonstrated that between 1959 and 2004, a hypothetical investment in a broad range of commoditiessuch as an indexwould have been no more risky than an investment in a broad range of stocks. Whats more, commodities showed a negative correlation with equities and a positive correlation with inflation. Food was always a good investment, and even better in bad times. Money managers could hardly wait to spread the news.

Since this discovery, reported the Financial Times, investors had become attracted to commodities in the hope that returns will differ from equities and bonds and be strong in case of inflation. Another study noted as well that commodity index funds offered an inherent or natural return that is not conditioned on skill. And so the long-awaited legion of new investors began buying into commodity index funds, and the food bubble truly began to inflate.

A few years after Facts and Fantasies appeared, and almost as if to prove Gorton and Rouwenhorsts point, the financial crisis hit mortgage, credit, and real estate marketsand, just as the scholars had predicted, those who had invested in commodities prospered. Money managers had to decide where to park what remained of their endowment, hedge, and pension funds, and the bankers were ready with something that looked very safe: in 2003, commodity index holdings amounted to a not particularly awe-inspiring $13 billion, but by 2008, $317 billion had poured into the funds. As long as the commodities brokers kept rolling over their futures, it looked as though the day of reckoning might never come. If no one contemplated the effects that this accumulation of long-only futures would eventually have on grain markets, perhaps it was because no one had never seen such a massive pile of long-only futures.

From one perspective, a complicated chain of cause and effect had inflated the food bubble. But there were those who understood what was happening to the wheat markets in simpler terms. I dont have to pay anybody for anything, basically, one long-only indexer told me. Thats the beauty of it. __

Mark Bagan, CEO of the Minneapolis Grain Exchange, invited me to his office for a talk. A self-proclaimed grain brat, Bagan grew up among bales, combines, and concrete silos all across the United States before attending Minnesota State to play football. As I settled into his oversize couch, admired his neatly tailored pinstriped suit, and listened to his soft voice, it occurred to me that if the grain markets were a casino, Mark Bagan was the biggest bookie. Without him, there could be no bets on hard red spring.

From our perspective, were price neutral, value neutral, Bagan said.

I asked him about the commodity index funds and whether they had transformed the traditional wheat market into something wholly speculative, artificial, and hidden. Why did anyone except bankers even need this new market?

There are plenty of markets out there that have yet to be thought of and will be very successful, Bagan said. Then he veered into the intricacies of running a commodities exchange. With our old system, we could clear forty-eight products, he said. Now we can have more than fifty thousand products traded. Its a big number, building derivatives on top of derivatives, but weve got to be prepared for that: the financial world is evolving so quickly, there will always be a need for new risk-management products.

Bagan had not answered my question about the funds, so I asked again, as directly as I could: What did he make of the fact that speculation in commodity index funds had caused a global run on hard red spring?

Bagan slowly shook his head, as though he were an elementary-school teacher trying to explain a basic conceptsubtraction? ice?to a particularly dense child. The Goldman Sachs Commodity Index did not include a single hard red spring future, he told me. Minneapolis wheat may have set records in 2008 and led global food prices into the stratosphere, but it had nothing to do with Goldmans fund. There just wasnt enough speculation in the hard red spring market to satisfy the bankers. Not enough liquidity. Bagan smiled. Was there anything else I wanted to know?

Plenty, but there was nothing more Bagan was about to disclose. As I left the office, I remembered the rumors Id heard at a grain-crisis conference in Washington, D.C., a few months earlier. Between interminable speeches about price ceilings and grain reserves, more than one wheat expert had confided, strictly on background, that at the height of the bubble, Minneapolis wheat had been cornered. No one could say whether the culprit had been Cargill or the Canadian Wheat Board or any other party, but the consensus was that as the world had cried for food, someone, somewhere, had been hoarding wheat. __

Imaginary wheat bought anywhere affects real wheat bought everywhere. But as it turned out, index traders had purchased the majority of their long wheat futures on the oldest and largest grain clearinghouse in America, the Chicago Mercantile Exchange. And so I found myself pushing through the frigid blasts of the LaSalle Street canyon. If I could figure out precisely how and when wheat futures traded in Chicago had driven up the price of actual wheat in Minneapolis, I would know why a billion people on the planet could not afford bread.

The man who had agreed to escort me to the floor of the exchange traded grain for a transnational corporation, and he told me several times that he could not talk to the press, and that if I were to mention his name in print he would lose his job. So I will call him Mr. Silver.

In the basement cafeteria of the exchange I bought Mr. Silver a breakfast of bacon and eggs and asked whether he could explain how index funds that held long-only Chicago soft red winter wheat futures could have come to dictate the spot price of Minneapolis hard red spring. Had the world starved because of a corner in Chicago? Mr. Silver looked into his scrambled eggs and said nothing.

So I began to tell him everything I knew, hoping he would eventually be inspired to fill in the blanks. I told him about Joseph in Egypt, Osaka in 1730, the Panic of 1857, and futures contracts for cat pelts, molasses, and onions. I told him about Goldmans replication strategy, Gorton and Rouwenhorsts 2005 paper, and the rise and rise of index funds. I told him that at least one analyst had estimated that investments in commodity index funds could easily increase to as much as $1 trillion, which would result in yet another global food catastrophe, much worse than the one before.

And I told Mr. Silver something else I had discovered: About two thirds of the Goldman index remains devoted to crude oil, gasoline, heating oil, natural gas, and other energy-based commodities. Wheat was nothing but an indexical afterthought, accounting for less than 6.5 percent of Goldmans fund.

Mr. Silver sipped his coffee.

Even 6.5 percent of the Goldman Sachs Commodity Index made for a historically unprecedented pile of long wheat futures, I went on. Especially when those index funds kept rolling over the contracts they already hadall of them long, only a smattering bought in Kansas City, none in Minneapolis.

And then it occurred to me: It was neither an individual nor a corporation that had cornered the wheat market. The index funds may never have held a single bushel of wheat, but they were hoarding staggering quantities of wheat futures, billions of promises to buy, not one of them ever to be fulfilled.

The dreaded market corner had emerged not from a shortage in the wheat supply but from a much rarer economic occurrence, a shock inspired by the ceaseless call of index funds for wheat that did not exist and would never need to exist: a demand shock. Instead of a hidden mastermind committing a dastardly deed, it was old Mike Mullins brainless entity, the investment instrument itself, that had taken over and created the effects of a traditional corner.

Mr. Silver had stopped eating his eggs.

I said that I understood how the index funds unprecedented accumulation of Chicago futures could create the appearance of a market corner in Chicago. But there was still something I didnt get. Why had the wheat market in Minneapolis begun to act as though it too had been cornered when none of the index funds held hard red spring? Why had the worlds most widely exported wheat experienced a sudden surge in price, a surge that caused a billion people

At which point Mr. Silver interrupted my monologue.

Index-fund buying had pushed up the price of the Chicago contract, he said, until the price of a wheat future had come to equal the spot price of wheat on the Chicago Mercantile Exchangeand still, the futures price surged. The result was contango.

I gave Mr. Silver a blank look. Contango, he explained, describes a market in which future prices rise above current prices. Rather than being stable and steady, contango markets tend to be overheated and hysterical, with spot prices rising to match the most outrageously escalated futures prices. Indeed, between 2006 and 2008, the spot price of Chicago soft red winter shot up from $3 per bushel to $11 per bushel.

The ever-escalating price of wheat and the newfound strength of grain markets were excellent news for the new investors who had flooded commodity index funds. No matter that the mechanism created to stabilize grain prices had been reassembled into a mechanism to inflate grain prices, or that the stubbornly growing discrepancy between futures and spot prices meant that farmers and merchants no longer could use these markets to price crops and manage risks.

No matter that contango in Chicago had disrupted the operations of the nations grain markets to the extent that the Senate Committee on Homeland Security and Governmental Affairs had begun an investigation into whether speculation in the wheat markets might pose a threat to interstate commerce.

And then there was the question of the millers and the warehousersthose who needed actual wheat to sell, actual bread that might feed actual people.

Mr. Silver lowered his voice as he informed me that as the price of Chicago wheat had bubbled up, commercial buyers had turned elsewhereto places like Minneapolis. Although hard red spring historically had been more expensive than soft red winter, it had begun to look like a bargain. So brokers bought hard red spring and left it to the chemists at General Mills or Sara Lee or Dominos to rejigger their dough recipes for a higher-protein variety.

The grain merchants purchased Minneapolis hard red spring much earlier in the annual cycle than usual, and they purchased more of it than ever before, as real demand began to chase the ever-growing, everlasting long. By the time the normal buying season began, drought had hit Australia, floods had inundated northern Europe, and a vogue for biofuels had enticed U.S. farmers to grow less wheat and more corn. And so, when nations across the globe called for their annual hit of hard red spring, they discovered that the so-called visible supply was far lower than usual. At which point the markets veered into insanity.

Bankers had taken control of the worlds food, money chased money, and a billion people went hungry.

Mr. Silver finished his bacon and eggs and I followed him upstairs, beyond two sets of metal detectors, dozens of security staff, and a gaudy stained-glass image of Hermes, god of commerce, luck, and thievery. Through the colored glass that outlined the deity I caught my first glimpse of the immense trading floor of the Chicago Mercantile Exchange. The electronic board had already begun to populate with green, yellow, and red numbers. __

The wheat harvest of 2008 turned out to be the most bountiful the world had ever seen, so plentiful that even as hundreds of millions slowly starved, 200 million bushels were sold for animal feed. Livestock owners could afford the wheat; poor people could not. Rather belatedly, real wheat had shown up againand lots of it. U.S. Department of Agriculture statistics eventually revealed that 657 million bushels of 2008 wheat remained in U.S. silos after the buying season, a record-breaking carryover. Soon after that bounteous oversupply had been discovered, grain prices plummeted and the wheat markets returned to business as usual.

The worldwide price of food had risen by 80 percent between 2005 and 2008, and unlike other food catastrophes of the past half century or so, the United States was not insulated from this one, as 49 million Americans found themselves unable to put a full meal on the table. Across the country demand for food stamps reached an all-time high, and one in five kids came to depend on food kitchens. In Los Angeles nearly a million people went hungry. In Detroit armed guards stood watch over grocery stores. Rising prices, mused the New York Times, might have played a role.

On the plane to Minneapolis I had read a startling prediction: It may be hard to imagine commodity prices advancing another 460 percent above their mid-2008 price peaks, hedge-fund manager John Hummel wrote in a letter to clients of AIS Capital Management. But the fundamentals argue strongly, he continued, that these sectors have significant upside potential. I made a quick calculation: 460 percent above 2008 peaks meant hamburger meat priced at $20 a pound.

On the ground in Minneapolis I put the question to Michael Ricks, chairman of the Minneapolis Grain Exchange. Could 2008 happen again? Could prices rise even higher?

Absolutely, said Ricks. Were in a volatile world.

I put the same question to Layne Carlson, corporate secretary and treasurer of the Minneapolis Grain Exchange. Yes, said Carlson, who then told me the two principles that govern the movement of grain markets: fear and greed.

But wasnt it part of a grain exchanges responsibility to ensure a stable valuation of our daily bread?

I view what were working with as widgets, said Todd Posthuma, the exchanges associate director of market operations and information technology, the man responsible for clearing $100 million worth of trades every day. I think being an employee at an exchange is different from adding value to the food system.

Above Mark Bagans oversize desk hangs a jagged chart of futures prices for the hard red spring wheat contract, mapping every peak and valley from 1973 to 2006. The highs on Bagans chart reached $7.50. Of course, had 2008 been included, the spikes would have, literally, gone through the roof.

Would the price of wheat rise again?

The flow of money into commodities has changed significantly in the last decade, explained Bagan. Wheat, corn, soft commoditiesI dont see these dollars going away. It already has happened, he said. Its inevitable.

Banpu has become the first Thai company on this extraordinarily long list of 250 foreign companies generating revenues exceeding $200 million a year out of Australia <http://www.maynereport.com/articles/2008/02/04-1045-248.html>. Banpu achieved its entry by launching a generous $6.20 a share offer for Centennial Coal, which values the equity in the company at $2.5 billion.

The other new additional entry to our major foreign investors list is courtesy of Singaporean company Wilmar paying $1.7 billion for CSR's iconic sugar business. Sugar was a rare category which had remained in local hands for more than a century. Not any more! Australia remains one of the most foreign owned first world economies anywhere and, if anything, the trend is accelerating, especially with all these Chinese government resource plays.

About Me

'Mission statement'.
I am convinced that jewish individuals and groups have an enormous influence on the world. The MSM are, for almost all people, the only source of information, and these are largely controlled by jewish people.
So there is a huge under-reporting on jewish influence in the world.
I see it as my mission to try to close this gap. To quote Henry Ford: "Corral the 50 wealthiest jews and there will be no wars." `(Thomas Friedman wrote the same in Haaretz, about the war against Iraq! See yellow marked area, blog 573)
If that is true, my mission must be very beneficial to humanity.